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Personal Savings=DI-Consumption
Factors that Determine SavingsDIAs DI declines---S declines45 degree reference lineC=DISavings=amount by which actual C
falls short of 45 degree line
Co
nsu
mp
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g
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o45
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C
S
Consumptionschedule
Savingschedule
C
S
Disposable Income
Disposable Income
SAVING
SAVING
DISSAVING
DISSAVING
MPC = Slope of C
MPS = Slope of S
MPC + MPS = 1
CONSUMPTION AND SAVING
PROPENSITIES
APC + APS=1Consumption/DISavings/DI
MPC + MPS=1Change in C/Change in DIChange in S/change in DI
Non-Income Determinants of C & S
1-wealth Real assets vs. financial assets Usually—if wealth increases-----C moves up; S down
2-expectations Expect recession---- Expect prices to rise tomorrow---
3-real interest rates If you borrow more---Consume more—save less At low interest rates—less incentive
4-household debt As % of DI Held constant when drawing C schedule If consumers increase debt---increase C more at each level
5-taxes Shift both C and S
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C0
S0
Disposable Income
Disposable Income
C1
S1
TERMINOLOGY, SHIFTS, & STABILITY
Increases inConsumptionMeans…
A DecreaseIn Saving
Co
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C0
S0
Disposable Income
Disposable Income
C2
S2
TERMINOLOGY, SHIFTS, & STABILITY
Decreases inConsumptionMeans…
An IncreaseIn Saving
Terminology
Change in amount consumed---move pt. to ptCaused by a change in GDP or
income Change in determinant
Redraw the entire graph
Interest rate investment relationship
Business—plants/inventory MC=interest rate paid for borrowing Vs. MB=expected rate of return on
investment
1st key determinant of Investment Spending 1-expected rate of return=profit Profit/cost Example:
Spend $10,000Make $12,000 net revenue
• Profit=2,000
• 2,000/10,000=20% rate of return• Rate of return=r
2nd determinant
Real rate of interest (i) Financial cost of borrowing Example:
If interest rate is 7% on $10,000• $700 interest cost• Compare to expected rate of return• $2,000-700=$1300 profit• r>i up to the point that r=i
Investment (billions of dollars)
Ex
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ate
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(pe
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14
12
10
8
6
4
2
0
INVESTMENTDEMAND
CURVE
5 10 15 20 25 30 35 40
I D
Interest Rate – InvestmentRelationship
What makes Investment Demand Shift?
1-acquisition, maintenance & operating costs
2-business taxes 3-technological change 4-stock of capital goods in hand 5-expectations